First, I'll need a place to start. For that, I often turn to The Motley Fool's free podcasts, of which my favorites are Rule Breaker Investing and MarketFoolery. Respective hosts David Gardner and Chris Hill break down simple stock selection methodology and their favorite companies in brief understandable segments, providing a perfect jumping-off point for beginning investors looking to get the basics, as well as for the more experienced who want fresh ideas.
Next: data and other information. I've said previously that my favorite starting point is Yahoo!Finance. Online today you can't find a more comprehensive, up-to-date, easier-to-navigate stockpile of free public company info. You'll discover recent financial statements, basic criterial calculations, insider (executive) histories and stock positions, and a broad-reaching searchable database of articles on every American public company, plus hundreds of internationals.
(A portion of what follows was originally published last summer. It's been edited and updated.)
Hopefully by now a few specific businesses look promising. When I'm thinking of investing my hard-earned money to buy into one of these businesses, I want to be able to
- Describe in one sentence exactly what the company does
- Identify the CEO by name, and whether she or he is a founder of the business
- Identify primary marketplace competitors
- Recall how the stock has done over the past 12 months
The next step is to start examining specific criteria— contrary to a lot of what we read, I generally find it more helpful to search qualitatively than quantitatively— that will help me decide if this company is one I want to own. Here's what I look for:
But a competitive advantage could be anything difficult to replicate, whether another company is currently competing or just thinking of getting into that market. Proprietary technology for example— or actual patents— can keep competition at bay for years. Think of what happened to the Sony Walkman line when Apple introduced the iPod. Plain old momentum, too, provides a hell of an advantage: look at the the uphill battle faced by anyone— including deep-pocketed Amazon— who tries to challenge Netflix in streaming TV.
3: Low
debt. I
generally don't like businesses which are capital-intensive: they require a
lot of expensive equipment or facilities which drag on their cash reserves and
profitability. As an example let's look at airlines. An airline has
extremely high fixed costs for equipment, fuel contracts, parts, logistics systems,
and lots of trained personnel and retirement/pension expense. An airline has to take on huge debt to finance these
costs, and the payments on that debt take a fat chunk out of profits. Because airlines
sell a commodity (a seat on this plane is largely no better than a seat on that
plane) they face brutal price competition, and when the economy dips, customers
travel less, and the airlines and their stocks frequently take a pounding.
So I look
for the line item Long Term Debt on any business's most recent
balance sheet, and what I want to see is total debt around 25% or less of the
company's annual revenues (this information is on the Balance Sheet of any
public company and is easy to find). I want to know is how much the company is
borrowing compared to how much they're selling, so I can get
a napkin-sketch idea how much the debt payments (usually 5-10% per year) drag on profitability.
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4: Be a customer. Many investors are interested only in what they can learn from financial statements, leadership 'guidance', or from technical analysis of charts and graphs. All of which is useful. But unlike them, I believe the customer experience is perhaps the most fundamental measure of a company's values and future opportunity. I'm pretty normal. So when my customer experience is substantially flawed (bad restaurant service, a crappy or crashing website, cheap fabrics, a lousy return policy) I am unlikely to come away feeling good about the company's prospects; that company's values would seem misaligned with mine. But when the customer experience is stellar, I imagine other customers will be as delighted as I was. I start to see possible future trajectories for that business, and I get interested in owning a piece. So whenever possible I prefer to buy companies I do business with directly (Amazon,
Netflix, Apple, Starbucks, Chipotle, Twitter) or whose products I've used extensively (Under Armour, Visa,
Disney, Imax). While I can research the financials and leadership and competition and operational efficiency, only being a customer gives me the ability to properly judge its products or its value proposition to other customers. Without that piece I have a lot less to
go on.
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| The original 1997 logo |
6. A great brand. This qualitative assessment is more art than science, and it requires me to look around at my community, at the news, current music, at my family, at teenagers in our circle, at colleagues, friends and neighbors. Is this brand popping up more? Are celebrities photographed using their products? Do my kids want me to buy something they make, or does it seem like their prices are rising a little faster than competitors? Am I noticing their stuff product-placed on TV? Does the company ever come up in general conversation? These are all signs that the business in question is hot or heating up, that it's coming of age. Good signs.
The important thing to bear in mind through this process is that I'm not simply buying something which represents the future success (or failure) of a company. It's not a bet. I'm becoming an owner of this business. Which means the business itself should be fun, exciting, and compelling for me. Otherwise I'll tire of it in a couple of years when it hits a rough patch, and that will make me want to sell. But real investing gains come only over the long term. So buy smart.